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Defense Infrastructure: Inventory Control Point Consolidation Savings Would Be Substantial (Letter Report, 08/13/97, GAO/NSIAD-97-157).

GAO reviewed the Office of the Secretary of Defense's (OSD) report on
its review of the Defense Logistics Agency's (DLA) management of all
Department of Defense (DOD) inventory control points (ICP).

GAO noted that: (1) OSD used conservative assumptions and cost factors
in estimating cost savings from consolidating service ICPs under DLA;
(2) its projected cost savings of $2.2 billion to $3.8 billion cover a
13-year period, fiscal years 1998 to 2010; (3) GAO believes this
approach to be reasonable, given the sensitive nature of the issue, the
limited amount of time to perform the review, and the data available;
(4) however, the projected cost savings estimates would be at least $1.3
billion to $2.3 billion greater if OSD used base realignment and closure
principles, such as estimating steady-state savings over a longer time
period and a present value analysis instead of a constant dollar
analysis; and (5) the potential savings would likely be greater yet if
the analysis included: (a) savings from all business process
improvements related to the consolidation; and (b) planned future
improvements to DOD's existing material management information systems.

--------------------------- Indexing Terms -----------------------------

     TITLE:  Defense Infrastructure: Inventory Control Point 
             Consolidation Savings Would Be Substantial
      DATE:  08/13/97
   SUBJECT:  Defense cost control
             Inventory control systems
             Cost effectiveness analysis
             Military downsizing
             Management information systems
             Statistical methods
             Military inventories
             Military materiel
             Federal agency reorganization
IDENTIFIER:  DOD Quadrennial Defense Review
             DOD Materiel Management Standard System
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================================================================ COVER

Report to the Secretary of Defense

August 1997



Defense Infrastructure


=============================================================== ABBREV

  BRAC - base realignment and closure
  COBRA - cost of base realignment actions
  DLA - Defense Logistics Agency
  DOD - Department of Defense
  ICP - inventory control point
  LMI - Logistics Management Institute
  NDP - National Defense Panel
  OSD - Office of the Secretary of Defense
  QDR - Quadrennial Defense Review

=============================================================== LETTER


August 13, 1997

The Honorable William S.  Cohen
The Secretary of Defense

Dear Mr.  Secretary: 

The National Defense Authorization Act for Fiscal Year 1996 directed
you to review the Defense Logistics Agency's (DLA) management of all
Department of Defense (DOD) inventory control points (ICP) and to
report the results to the congressional defense committees and the
Comptroller General of the United States.  Your report identified
large savings as well as potential risks associated with
consolidating ICPs under DLA.  We reviewed the report and are
providing our observations on the estimated consolidation savings. 
Your report, along with our observations, may be useful to the
National Defense Panel (NDP) and others as they assess matters raised
by the Quadrennial Defense Review (QDR) relating to DOD's logistics

------------------------------------------------------------ Letter :1

The Office of the Secretary of Defense (OSD) used conservative
assumptions and cost factors in estimating cost savings from
consolidating service ICPs under DLA.  Its projected cost savings of
$2.2 billion to $3.8 billion cover a 13-year period, fiscal years
1998 to 2010.  We believe this approach to be reasonable, given the
sensitive nature of the issue, the limited amount of time to perform
the review, and the data available.  However, the projected cost
savings estimates would be at least $1.3 billion to $2.3 billion
greater if OSD used base realignment and closure (BRAC) principles,
such as estimating steady-state savings over a longer time period and
a present value analysis instead of a constant dollar analysis.\1 The
potential savings would likely be greater yet if the analysis
included (1) savings from all business process improvements related
to the consolidation and (2) planned future improvements to DOD's
existing material management information systems. 

\1 A present value analysis calculates the value of future dollar
amounts in terms of present dollars by recognizing the time value of
money.  In the calculation, the future monetary amounts are
"discounted" to the present using the appropriate interest or
discount rate. 

------------------------------------------------------------ Letter :2

ICPs provide services associated with the acquisition, distribution,
maintenance, and disposal of consumable and reparable parts,\2 and
supplies needed to operate weapon systems and components.  DLA
manages 5 ICPs at 5 locations, and the services manage 11 ICPs at 13
locations.  DLA's ICPs manage consumable items such as repair parts,
personnel support items, fuel, and other bulk items and material. 
The services' ICPs manage reparable components, subsystems, and
assemblies and selected consumable items.  The 16 ICPs employ about
24,000 people and manage parts valued at approximately $69 billion. 
The number of ICPs is expected to be reduced to 11 ICPs at 13
locations by fiscal year 2003.\3 (See app.  I for a list of service
and DLA ICPs by location and by those that are scheduled for

In past reports, we criticized DOD's logistics system as being
cumbersome, inefficient, and costly.  Likewise, since at least the
1970s, DOD has recognized and been concerned about overlap and
duplication in its logistics system and other inefficiencies.  In
1989, OSD proposed a review to consolidate ICPs under a single
service or agency manager, but the services strongly opposed the idea
because they believed their ability to support weapon systems
effectively would be adversely affected.  However, in the National
Defense Authorization Act for Fiscal Year 1996, Congress required the
Secretary of Defense to review the management of all DOD ICPs by DLA,
including service-managed reparable items.\4 Thus, in April 1996, the
Deputy Under Secretary of Defense for Logistics tasked the Logistics
Management Institute (LMI) to conduct such a review. 

On November 19, 1996, OSD reported the results of its review to
Congress and provided a copy to the Comptroller General of the United
States.  The report concluded that cumulative savings during fiscal
years 1998 to 2010, ranging from $2.2 billion to $3.8 billion, might
accrue if the management of all ICPs were transferred to DLA.  The
report also noted the services' concerns regarding the transfer,
principally the risk of disrupting the intraservice integration of
material and weapon system management.  The report noted, however,
that actions could be taken to lessen the risks.  Given the services'
concerns, the report stated that DOD, through its QDR and other
future planning and programming efforts, would examine alternatives
that might provide similar savings at less overall risk. 

\2 Consumable parts are generally not cost-effective to repair and
are thrown away when worn or broken; reparable parts can be repaired
at maintenance activities when worn or broken. 

\3 DLA's Defense Fuels Supply Center is collocated with DLA's
headquarters at Fort Belvoir, Virginia, and is not included in these
downsizing numbers. 

\4 The July 1990 ICP Consolidation Study (Defense Management Report
Decision 926) directed the services to transfer service-managed
consumables to DLA.  This effort began in August 1991 and is
scheduled to be completed by January 1998. 

------------------------------------------------------------ Letter :3

LMI developed a scenario for consolidating the service ICPs under a
single manager within DLA and identified the associated potential
costs, benefits, and risks.  LMI recognized that if the proposed
consolidation were to occur, the implementation might differ from its
scenario, and the major personnel reductions and site consolidations
envisioned in the review would likely have to undergo a process
similar to that recently used for BRAC actions.  Therefore, LMI
considered its analysis conceptual in nature because it did not
address specifics, such as which ICPs to close and which to retain. 
The analysis was intended to indicate only whether the consolidation
has merit. 

Under LMI's scenario, the consolidation would take place during
fiscal years 1998-2010, reduce the number of ICPs\5 to either six or
three,\6 and affect at least 12,000 people.  Figure 1 is a chronology
of LMI's scenario, the actions projected to occur, and the associated
range of savings. 

   Figure 1:  LMI's Consolidation

   (See figure in printed

Note:  The total savings from fiscal year 1998 to 2010 is $2.2
billion to $3.8 billion. 

To identify the cost savings of its scenario, LMI considered three
areas through which savings were possible:  (1) a transfer in place,
(2) site consolidation, and (3) business process improvements.  (See
app.  II for a list of the business improvements identified by LMI.)

LMI developed the cost savings for the transfer in place and site
consolidations using the services' and DLA's ICP and supporting
headquarters cost data.  For the business process improvements,
however, LMI could not obtain complete data from the services for all
16 improvements, but was able to price 4 individual initiatives that
would result from the transfer.  To develop the potential cost
savings in these areas, LMI used cost factors and made assumptions
that were conservative in nature.  According to an LMI official, the
team's conservative approach was designed to avoid overstating the
anticipated cost savings. 

\5 DLA's Defense Fuels Supply Center was not part of OSD's review and
was therefore not included in LMI's analysis. 

\6 Using these two options, LMI provided a range of the potential
savings.  The use of six ICP locations represents the low end of
LMI's cost savings and reflects conservative assumptions, and the use
of three represents the high end to reflect relatively aggressive

------------------------------------------------------------ Letter :4

After examining the report on consolidation, we believe OSD's
approach was reasonable, given the sensitive nature of the issue, the
limited amount of time to perform the review, and the data available. 
However, we concluded that the cost savings estimates would have been
$1.3 billion to $2.3 billion greater if BRAC principles had been
used.  Also, indications are that the savings estimates would be even
greater if the review included the savings associated with all 16
business process improvements and likely future improvements to the
material management information systems.  Full achievement of these
additional savings is dependent on the consolidation of the ICPs
under a single manager. 

---------------------------------------------------------- Letter :4.1

Given the short time frame LMI had to review the ICP consolidation,
it performed a conceptual analysis to show whether savings were
possible.  It did not use the cost of base realignment actions
(COBRA) model, which was used during the four BRAC rounds since 1988
to evaluate the cost of stationing alternatives.  Although LMI was
not required to use the model, COBRA was the proven, standard means
for analyzing proposed consolidations. 

We recognize the difficulty in using the COBRA model because it
requires the collection of a large amount of data and numerous
assumptions, such as which sites to retain and which to close.  Had
LMI used some of the BRAC principles that were used in the COBRA
model, such as a longer period of steady-state savings and a present
value analysis in arriving at its cost savings estimates, the
combined effect would have resulted in larger estimated savings.\7
More importantly, using these BRAC principles provides a way of
showing cost savings estimates that are consistent with how DOD
projected costs and savings in previous BRAC rounds.\8

To illustrate, BRAC legislation required that consolidations be
completed in no more than 6 years and that DOD project savings over a
20-year period, thus ensuring at least 14 years of steady-state
savings.  BRAC also required the use of a present value analysis to
reflect the value of money over time.  LMI projected cost savings
over a 13-year period (i.e., fiscal
years 1998-2010), which included an 11-year implementation period and
2 years of steady-state savings.  Its analysis also did not consider
the time value of money.  An LMI official told us that, given more
time, it would have considered using a present value analysis and a
longer time period. 

We adjusted LMI's cost savings estimates by applying these two BRAC
principles without changing LMI's scenario or assumptions. 
Specifically, we extended LMI's ending time frame from fiscal year
2010 to 2022 to allow 14 years of steady-state savings and performed
a present value analysis on LMI's cost savings estimates, using a
rate of 4 percent.\9 Table 1 shows the results of our adjustments. 

                                Table 1
                    Projected Cost Savings Estimates

                         (Dollars in billions)

                                                 Years of
                Consolidatio                      steady-    Projected
                  n period--  Discount rate         state         cost
Projected by    fiscal years  (percent)           savings      savings
--------------  ------------  ---------------  ----------  -----------
LMI             1998 to 2010  None                      2      $2.2 to
GAO                  1998 to  4.00                     14      $3.5 to
                      2022\a                                      $6.1
\a To ensure 14 years of steady-state savings without changing LMI's
assumptions, we had to extend the time period. 

LMI's analysis could be adjusted in many ways if the scenario
assumptions were changed.  We could have used a 20-year period
(fiscal years 1998-2017), which would include 14 years of
steady-state savings.  Although we believe this alternative
calculation would generate savings similar to or greater than those
from our analysis, we would have had to make numerous assumptions
about LMI's consolidation scenario.  For example, by achieving
consolidation within the first 6 years (i.e., between fiscal
year 1998 and 2003, or sooner), DOD could increase the potential cost
savings even more.  We have previously reported on the effect of
implementing BRAC actions sooner and the resulting increase in

\7 In a present value analysis cost savings estimates are decreased,
but if the time period is also extended, the net effect is an
increase in the cost savings estimates. 

\8 We recognize that BRAC legislation expired on December 31, 1995. 
However, the use of these principles is an approved and established
procedure DOD has used in the past to examine closure and realignment

\9 Since the costs and savings were in constant dollars (i.e.,
excluded inflation), we used a real discount rate of 4 percent (i.e.,
a nominal interest rate of 6.9 percent minus a projected inflation
rate of 2.9 percent) for our present value analysis.  For the nominal
interest, we used the yield on U.S.  Treasury bonds for the period of
our analysis, and for the projected inflation rate, we used the
average of inflation forecasts from two major economic forecasting

\10 Military Bases:  Closure and Realignment Savings Are Significant,
but Not Easily Quantified (GAO/NSIAD-96-67, Apr.  8, 1996). 

---------------------------------------------------------- Letter :4.2

The savings identified in LMI's analysis do not include potential
savings from all 16 business process improvements and a DOD-wide
material management information system.  We were unable to quantify
these associated costs and savings, but we believe their inclusion
into LMI's analysis would increase LMI's cost savings estimates. 

-------------------------------------------------------- Letter :4.2.1

Although LMI identified 16 business process improvements from which
savings could be anticipated, it estimated costs and savings for only
4.  These four, however, account for a significant portion of the
overall estimated savings--ranging between $1.5 billion and $2.7
billion.  Nevertheless, the additional 12 could also result in
savings.  According to LMI officials, these business process
improvements are a sample of improvements that DLA could make as a
single manager for all DOD ICPs, to include improving the contracting
methodology and process, deleting inactive parts, and improving
material acquisitions and inventory storage.  According to an LMI
official, LMI estimated savings for only four improvements because of
the lack of data, time constraints, and limited resources. 

Service officials stated that the savings associated with these four
process improvements duplicate ongoing service efforts and should not
be considered in this analysis.  However, they did not provide data
to support their statements.\11 We believe that even greater savings
could be achieved if the business process improvements were
implemented by a single manager across service lines for all of DOD's

\11 Only the Navy provided documentation; however, most of its
process improvements were conceptual and would be limited to the

-------------------------------------------------------- Letter :4.2.2

At the time of LMI's analysis, DOD was planning to implement the
Material Management Standard System to be used at its ICPs.\12 In
July 1995, DOD estimated it would spend about $5.3 billion to
develop, deploy, and maintain the system at its ICPs, and it expected
the effort to produce as much as $15 billion in savings over a
15-year period.  According to an LMI official, Material Management
Steering Group officials told the LMI team not to consider using
these numbers because of the questionable costs and savings
estimates.  We later reported that DOD had underestimated the costs
and overestimated the savings.\13

Because of difficulty in developing the system, the strategy to
develop and implement a standard material management system was
abandoned.  According to a former senior official involved in the
development of the system, progress was marred by incompatible
service goals that could be overcome if the ICPs were consolidated
under a single organization such as DLA.  DOD officials told us that
they did not believe a standard system would work, considering the
differences in how each service does business.  However, LMI and
several military officials said that a standard database that could
be shared was needed.  Although the costs and savings associated with
a standard system are not easily quantifiable, we believe that
successful implementation of a standard system or database would be
more likely and savings would be achievable under a single

\12 This system was intended to be independent from over 500 existing
systems to carry out wholesale logistics operations.  The systems
cost billions of dollars in maintenance and increasingly result in
unnecessary requisitions and excess inventory. 

\13 Defense IRM:  Critical Risks Facing New Materiel Management
Strategy (GAO/AIMD-96-109, Sept.  6, 1996). 

------------------------------------------------------------ Letter :5

The National Defense Authorization Act for Fiscal Year 1997
established the QDR to examine defense requirements and strategy and
develop a revised defense program through 2005.  The act also
established an NDP to review the QDR's work and provide you with
recommendations for improvements to the QDR's review, which it did on
May 15, 1997.  In addition, the NDP will report to you on additional
matters by December 1, 1997. 

DOD established a QDR Infrastructure Panel Logistics Task Force to
examine DOD's infrastructure issues, including ICP consolidation
alternatives.  The Logistics Task Force considered six alternatives
(see app.  III for a list of all six alternatives) and decided
against consolidating service ICPs and reparable inventory under DLA,
even though the savings estimates were much greater than any other
alternative.  Instead, the task force recommended establishing one
ICP per service with multiple locations.  Only the recommended
alternative was forwarded to the NDP for its consideration. 

In the NDP's May 15, 1997, report, the NDP reported on the QDR's
changes and reductions to DOD's infrastructure but did not
specifically address ICP consolidation.  According to an NDP staff
member, DOD infrastructure issues are still being considered by the
Panel, but it is uncertain whether ICP infrastructure will be
addressed in the NDP's December 1, 1997, report. 

------------------------------------------------------------ Letter :6

Although substantial savings are possible by consolidating the
services' ICPs under DLA, the services have resisted such proposals,
citing potential risks that could affect operational effectiveness. 
Given this situation, we recommend that you ask the NDP to examine
the savings and risks associated with ICP consolidation under DLA. 

As you know, 31 U.S.C.  720 requires the head of a federal agency to
submit a written statement on actions taken on this recommendation to
the Senate Committee on Governmental Affairs and the House Committee
on Government Reform and Oversight not later than 60 days after the
date of the report and to the Senate and House Committees on
Appropriations with the agency's first request for appropriations
made more than 60 days after the date of the report. 

------------------------------------------------------------ Letter :7

DOD generally concurred with our findings, but stated that without
addressing the risks associated with the consolidation, our cost
savings projections would not be very meaningful.  (See app.  IV for
a reproduction of DOD's comments.) We agree with DOD that the risks
cannot be ignored.  However, as indicated in the OSD report, these
potential risks can be mitigated.  Given these circumstances, we
believe that the NDP should examine both the savings and risks
associated with the consolidation of ICPs under DLA.  Although this
recommendation was not in the draft report DOD reviewed, our
subsequent review of the QDR and NDP reports prompted us to add this

------------------------------------------------------------ Letter :8

During our review, we evaluated matters related to the cost of the
proposed transfer of service-managed ICPs to DLA.  We did not address
the risks associated with the proposed transfer, nor did we examine
any of DOD's ongoing initiatives in the logistics infrastructure
area.  However, we did obtain some information on pertinent matters
considered by the Logistics Infrastructure Panel of the QDR. 

To obtain an overall service perspective on the cost aspects of the
report, we held discussions with cognizant officials from OSD; the
Joint Chiefs of Staff; and headquarters and installations of the
Army, Navy, Marine Corps, Air Force, and Defense Logistics Agency,
and reviewed documents provided by the services.  Locations visited
included the Communications and Electronics Command, Fort Monmouth,
New Jersey; the Naval Inventory Control Point and Naval Supply
Systems Command, Mechanicsburg, Pennsylvania; Naval Sea Systems
Command, Washington D.C.; Air Force Materiel Command, Dayton, Ohio;
and Oklahoma City Air Logistics Center, Oklahoma City, Oklahoma. 

To understand the report's methodology for estimating costs, we
talked with OSD and LMI officials, reviewed LMI-prepared data\14 and
spreadsheets, and randomly checked LMI's calculations.  To estimate
additional potential cost savings, we adjusted LMI's data to include
a longer time period of steady-state savings and a present value

We conducted our review between December 1996 and June 1997 in
accordance with generally accepted government auditing standards. 

\14 Most of the information we used had been summarized in an
LMI-prepared draft (Consolidation of DOD Inventory Control Points
Under the Defense Logistics Agency:  An Analysis of the Risks and
Benefits, Jan.  28, 1997). 

---------------------------------------------------------- Letter :8.1

We are sending copies of this report to the Chairmen and Ranking
Minority Members of the Senate Committee on Armed Services and the
House Committee on National Security.  We will make copies available
to others on request.  Please contact me on (202) 512-8412 if you or
your staff have any questions about this report.  Major contributors
to this report were George Jahnigen, Kevin Perkins, and David

Sincerely yours,

David R.  Warren, Director
Defense Management Issues

=========================================================== Appendix I

   (See figure in printed

\a These two activities are being combined as a result of a 1995 base
realignment and closure (BRAC) action. 

\b This activity was not part of the Office of the Secretary of
Defense's (OSD) review. 

========================================================== Appendix II

                                                              Savings estimated
Business process improvement                                  in LMI's analysis
------------------------------------------------------------  ------------------
Improved contracting methodology and process: Improves        Yes
contracting efficiency by emphasizing corporate contracting
and reduced acquisition lead times.

Deletion of inactive items: Deletes from DOD's catalog items  Yes
for which no current applications have been identified,
thereby reducing item management costs.

Catalog total quality management: Corrects catalog data,      No
which will facilitate correct requirements computations and
decisions to repair or procure.\a

Improved demilitarization: Corrects coding errors dealing     No
with demilitarization responsibilities and facilitates
timely disposal of excess material.

Improved stock positioning: Uses better data on               No
requisitioner locations to reposition stock and decreases
shipping and storage costs and response time.

Item reduction and entry control: Reviews items during        No
weapon system design phase to identify all equivalent items,
leading to reductions in items to be managed and inventory

Secondary-item provisioning on end-item contracts:            No
Establishes a DOD program to deal with provisioning line
items with end items, thereby reducing procurements and
potentially reducing prices as administrative costs are

Source breakout: Strengthens DLA's program to identify        No
subcontractors and other less costly sources of supply.

Workloading of depot maintenance: Provides maintenance        No
depots with better reparable parts induction scheduling,
resulting in reduced inventories.

Integration of initial and replenishment requirements:        Yes
Integrates requirements procedures used by program managers
to combine computation of initial inventory and
replenishment levels.

Single set of ICP policies and procedures: Eliminates         Yes
current duplication of policies and procedures among the
services and DLA for secondary items, thereby generating
personnel savings.

Integration of wholesale and retail requirements: Reduces     No
wholesale and retail inventory investment by using
procedures that integrate wholesale and retail
responsiveness and inventory costs.

Reduction of service-unique catalog data: Eliminates unique   No
service management codes, thus reducing costs associated
with data management.

Single design activity for materiel management system:        No
Combines into one DLA activity the activities of service
design agencies that develop and maintain service-unique
software for managing secondary items.

Single ICP managing items on a weapon system: Realigns item   No
management along weapon system lines, eliminating file
duplication and facilitating computations using weapon
system readiness goals.

Uniform credit policy for returns: Establishes a single       No
policy for giving credit to organizations returning
materiel, thereby simplifying budgeting and accounting at
customer levels and industrial fund accounting.
\a This process improvement was considered by OSD outside of this
review.  The decision to consolidate cataloging functions was
announced on March 18, 1997. 

========================================================= Appendix III

Alternative             Description             Components involved
----------------------  ----------------------  ----------------------
Consolidation of        Consolidation of        All DOD components
selective functions     selective ICP
                        functions at a single
                        site within a region.

Global Primary          One wholesale manager   Military services
Inventory Control       for a common-use
Activity                reparable item (or for
                        similar common use
                        reparable items).

Partnerships            Electronic networking   All DOD components
                        and tasking to link
                        ICPs and provide for a
                        mechanism for
                        executing partnership
                        (intra-or inter-

Intra-component         Reduction of each DOD   All DOD components
consolidation\a         component's ICPs
                        (e.g., 1 ICP per
                        service and 1 or 2
                        ICPs for DLA).

Single management       Assignment of ICP       Military services
element                 management to all
                        services, except the
                        Marine Corps, along
                        weapon system lines
                        (e.g., Air Force -
                        aircraft, Navy -
                        ships, and Army -
                        ground equipment).

DLA as single           Management of all DOD   All DOD components
manager\b               ICPs under DLA.
\a This alternative was selected by the Quadrennial Defense Review
and forwarded to the National Defense Panel. 

\b This alternative was reviewed by OSD as required by the National
Defense Authorization Act for Fiscal Year 1996. 

(See figure in printed edition.)Appendix IV
========================================================= Appendix III

*** End of document. ***

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